The Short Dollar & The Debt Bubble

Posted Mar 29, 2013 by Martin Armstrong

Everyone keeps touting the demise of the dollar. They seem to be unaware of the global private debt bubble in dollars and how bullish that can be. During the 1980’s, banks in Australia sold Swiss loans on the basis that was the way to save massive interest with no view of the A$ whatsoever. Then the Swiss rallied and A$ fell and the losses to borrowers were massive. This even altered the capital flows confusing the hell out of economists. Back then, there were countless bankruptcies and it was good business for us for we were getting called in among Australia’s top 50 companies all dealing with currency losses on a grand scale.

Well, the short dollar debt bubble has been rising globally and in some respects for perfectly rational reasons in Europe and especially in Asia. Lending and borrowing have been encouraged by super low interest rates and bogus analysts who kept swearing the dollar would move lower, gold would soar, so borrow in dollars and you will pay back with funny money. This attitude has created a global private debt bubble with everyone expecting to profit from a dollar collapse. Unfortunately, as the Euro presses lower because of massive structural problems that have revealed that currency could NEVER rise as a true RESERVE currency displacing the dollar lacking a single national debt, the risks associated with a dollar rally are just off the charts.

Rising debt levels are a natural outgrowth of rising wealth that has been emerging in Asia. As economies advance, financial sectors become more advanced and debt tends to increase. Nevertheless, there are reasons to be concerned about what’s going on in Asia. These economies are requiring more debt to keep going and privately have been following the West down the primrose path of financial indebtedness.

Asia is not as economically healthy as its GDP growth rates suggest. There are growing debt problems with much of the debt in dollars. The economic growth is highly credit-dependent, which in fact provides leverage.Fundamentally, this is a trend we must respect comes with risks because of the cross currency borrowing that introduces massive currency exposure. The dollar has provided incredibly easy money conditions in the entire global economy. This extends far beyond the Fed’s balance sheet and in fact, the Fed looks conservative compared to the rest of the world no less the ECB. Debt has the possibility to rise even further, as financial institutions are under pressure to lend money as evidenced in the USA with mortgage rates dropping below 4%.

The analysis that constantly harp about the Fed and its quantitative easing being massively bearish for the dollar have only helped to create this dollar bubble that is the mirror image of gold. We are beginning to enter the more interesting stage as we await the final break in gold, but the shift in even more capital from Europe that is helping the US share market explode most likely going into a May high, is lining up with a Euro low initially also in May.

The dollar rise into 1985 was similarly fueled by massive dollar bearishness and goldbugs swearing new highs were around the corner. In 1980, the US national debt hit $1 trillion when gold hit $875 and the Eurodollar deposits also reached $1 trillion. Europeans were convinced as all the press there touted the way the USA would get out of its debt bubble was to create a two-tier dollar with green ones still domestic and red ones for Eurodollars. This belief led to huge capital outflows from Eurodollar deposits that collapsed by 50% going into 1985 shifting to domestic dollar deposits that they believed would be worth more. As the bearish dollar view expanded, the dollar rose even further.

This is what has taken place in recent times. The cry that the dollar will collapse because of Fed quantitative easing has been used to both sell gold and dollar loans. The Fed’s $3 trillion expansion was merely offset by the near $6 trillion in capital contraction by the deleveraging. Hence, the net effect fo QE1, QE2, and QE3 have utterly failed to produce the hyperinflation that the majority were forecasting.

This expansion by the Fed helped to create a gold rally, but more significantly, it created a short dollar bubble in debt on a global scale that will cause a dollar rally which will shock the borrowers just as the Australians who were borrowing in Swiss. The extensive short dollar positions through dollar loans counting on its demise, is enough fuel to cause the dollar rally. This is being egged on by the stupidity in Europe at the ECB over this whole Cyprus deal. As geopolitical concerns also rise in Japan with North Korea threatening everyone, the dollar is poised to move higher there. In Britain, the economic decline continues and we may even see negative growth rates there as they become also hunters of the rich and applying their tax laws internationally. The Swiss pegged their currency to the Euro to try to fend off capital flight there but with Russia pissed off over Cyprus, the safer bet is the dollar.

In Australia they called it “the economic equivalent of Mission Impossible” where their burgeoning foreign debt problem was accelerated by a government that did not understand capital flows any more that they do today or most conventional analysts still stuck in the Bretton Woods era of increase money supply must be inflationary ignoring international trends. The Australian Hawke Government at the time claimed to have the answer by tight monetary policy and high interest rates. But the loans were in Swiss. The more they raised interest rates, the greater the A$ rose and this increased the losses in foreign loans. The current account deficit rose because what was included in that is interest payments. The Australian government totally screwed up everything because they were clueless. Meanwhile, academics are focused intensely only on domestic models trying to apply random walks and market efficiency concepts unable to look at anything else like a 12 year old boy who sees his first nude woman unable to even blink.

So hang on to your seat. The press, government, herd of domestically fixated analysts, and most spellbound economists have no clue what has been created because they do not look to the horizon and do not understand the accounting system government are using in any event. As the dollar rises, Washington will call it a currency war, raise interest rates to discourage dollar loans, engage in protectionism, and this will create a feed-back loop sending the currency higher as was the case with the A$ and the Great Depression. Then we have the Sovereign Debt Crisis on top of this mess. So for all those touting the demise of the dollar, the majority are always wrong because that is the fuel that drives the markets. The majority MUST be wrong to create the swings within the economic pendulum. So don’t worry, be happy, we need those people to make money and survive.

When we look at our Dollar Index 1900=Par, we see a starkly bullish chart. The dollar has remained within the uptrend channel for the last century. It has never closed out of it yet. The secondary channel created from the World War I and 1931 high will provide the major technical resistance above the 1985 high when they formed G5 to manipulated the dollar lower creating the 1987 Crash & 1989 Japan Bubble. Even our Energy Model shows the dollar is FAR from over-bought and we can see the flat-line created by Bretton Woods for a brief shining moment. It certainly appears that the US dollar will befuddle everyone as it did before and the A$. We are looking at record highs ABOVE that of 1985 before this flips. So just as the 1980-1985 period when dollar bearishness was at its height yet the dollar rose, we are looking at a similar situation once again.

Both economics and geopolitical trends are conspiring to produce a strong dollar that the majority will never understand until it is too late mumbling – But the Fed increased the money supply! Yes – there is also the other side of that coin, it is called DEMAND!